In researching how information asymmetry played a role in mortgage defaults, I found at least two types of asymmetry. The first is between a home buyer and the mortgage company. The second is between the lender and the insurer. Although I have a mortgage of my own, I am not too familiar with all of the mortgage types and other background information.
The information asymmetry ...view middle of the document...
For example, with an option ARM, the first couple years there is nothing or little owed on the principle, and some owners choose to pay nothing. But after that period of no principle due, the principle has increased and the owner cannot afford the mortgage. If the owner knew not paying any towards the principle would make it harder to pay later, they may have made different financial decisions.
The other information asymmetry is between the lender and the protection seller (insurer). The lender had the information advantage on the buyers’ credit, and the insurer did not have the ability to evaluate the quality of the loan. The lender would screen buyers and decide to buy protection if necessary. But with buying protection via a CDS, the lender would screen buyers even less. When there were few mortgage defaults, the system was working, but as they increased, the system failed.
Both of these examples of information asymmetry contributed to the increase in mess of mortgage defaults